Money Girl explains the costs of buying and leasing a car, the main pros and cons of each option, and how to get the best return on your investment depending on your lifestyle, budget, and financial goals.
Unless you live in a big city that offers public transportation or car sharing services, you probably rely on your own vehicle to get to work, run errands, or have fun. For many people, paying for a vehicle is one of the biggest expenses the have. But knowing whether you should buy or lease a car can be confusing.
In this episode, I’ll explain the costs associated with both buying and leasing a car. You’ll find out the main pros and cons of each option, and how to get the best return on your investment depending on your lifestyle, budget, and financial goals.
What’s the Cost of Buying a Car?
When you buy a new or used car, you probably know that you can pay cash or get an auto loan. However, whether you can get approved for a loan, how much the loan will be for, and the interest rate you’ll pay depends on factors such as your credit score, income, and the age of the vehicle.
No matter if the car you want to finance is used or brand new, you generally have to make a down payment in the range of 10% to 20% of the car’s price. For instance, if you want a $20,000 vehicle, you might have to pay $4,000 of your own money in order to receive $16,000 from a lender.
But what if you don’t have any savings for a down payment? Zero- or low-down payment car loans do exist. However, they charge higher interest rates, which means you’ll have higher monthly payments and end up paying much more interest over the life of the loan.
And by the way, don’t confuse a zero-down loan with a zero-interest loan. Sometimes you can get a “zero down and zero interest” special deal, but only in rare cases where a dealer offers it - and you have excellent credit.
See also: Credit Score Survival Kit - a free tutorial to build credit fast!
What Is Being "Upside Down" on a Car?
While it might seem great to pay little or nothing out of pocket for a car, it comes with a huge downside, which is called being “upside down.” No, I’m not talking about your car flipping over in an accident. Upside down is a common term for what happens when you owe more money for a car than it’s worth.
Unfortunately, most vehicles depreciate very quickly. New cars can lose as much as 25% of their value after the first year of ownership, depending on the make, model, condition, and state of the used-car market.
Used cars also depreciate, but much more slowly. That’s why buying a second-hand vehicle can be a great deal; the original owner takes the biggest depreciation hit, not you. The vast majority of vehicles that I’ve purchased have been pre-owned for this reason.
After accounting for depreciation, sales tax, and registration costs, it’s easy to see why you can be upside down right away, especially if you make a low- or no-down payment on a vehicle. Here’s the problem: If you need to sell the car or it gets totaled in an accident, you might not receive enough money to pay off your loan. A buyer or an insurance company will only give you market value for a vehicle, not what you still owe on your loan. You might have the make up the difference from your own savings.
The best way to prevent being upside down on a car loan is to make as big a down payment as possible, so you have equity in the vehicle. That also increases your chances of getting approved for a loan in the first place, reduces your monthly payments, cuts your interest expense, and offsets the inevitable depreciation.
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